Junk-Rated Oil & Gas Companies in a “Liquidity Death Spiral”

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On the face of it, the oil price appears to be stabilizing. What a precarious balance it is, however.

Behind the façade of stability, the rebalancing triggered by the price collapse has yet to run its course, and it might be overly optimistic to expect it to proceed smoothly. Steep drops in the US rig count have been a key driver of the price rebound. Yet US supply so far shows precious little sign of slowing down. Quite to the contrary, it continues to defy expectations.

So said the International Energy Agency in its Oil Market Report on Friday. West Texas Intermediate plunged over 4% to $45 a barrel.

The boom in US oil production will continue “to defy expectations” and wreak havoc on the price of oil until the power behind the boom dries up: money borrowed from yield-chasing investors driven to near insanity by the Fed’s interest rate repression. But that money isn’t drying up yet – except at the margins.

Companies have raked in 14% more money from high-grade bond sales so far this year than over the same period in 2014, according to LCD. And in 2014 at this time, they were 27% ahead of the same period in 2013. You get the idea.

Even energy companies got to top off their money reservoirs. Among high-grade issuers over just the last few days were BP Capital, Valero Energy, Sempra Energy, Noble, and Helmerich & Payne. They’re all furiously bringing in liquidity before it gets more expensive.

In the junk-bond market, bond-fund managers are chasing yield with gusto. Last week alone, pro-forma junk bond issuance “ballooned to $16.48 billion, the largest weekly tally in two years,” the LCD HY Weekly reported. Year-to-date, $79.2 billion in junk bonds have been sold, 36% more than in the same period last year.

But despite this drunken investor enthusiasm, the bottom of the energy sector – junk-rated smaller companies – is falling out.

Standard & Poor’s rates 170 bond issuers that are engaged in oil and gas exploration & production, oil field services, and contract drilling. Of them, 81% are junk rated – many of them deep junk. The oil bust is now picking off the smaller junk-rated companies, one after the other, three of them so far in March.

On March 3, offshore oil-and-gas contractor CalDive that in 2013 still had 1,550 employees filed for bankruptcy. It’s focused on maintaining offshore production platforms. But some projects were suspended last year, and lenders shut off the spigot.

On March 8, Dune Energy filed for bankruptcy in Austin, TX, after its merger with Eos Petro collapsed. It listed $144 million in debt. Dune said that it received $10 million Debtor in Possession financing, on the condition that the company puts itself up for auction.

On March 9, BPZ Resources traipsed to the courthouse in Houston to file for bankruptcy, four days after I’d written about its travails; it had skipped a $60 million payment to its bondholders [read… “Default Monday”: Oil & Gas Companies Face Their Creditors].

And more companies are “in the pipeline to be restructured,” LCD reported. They all face the same issues: low oil and gas prices, newly skittish bond investors, and banks that have their eyes riveted on the revolving lines of credit with which these companies fund their capital expenditures. Being forever cash-flow negative, these companies periodically issue bonds and use the proceeds to pay down their revolver when it approaches the limit. In many cases, the bank uses the value of the company’s oil and gas reserves to determine that limit.

If the prices of oil and gas are high, those reserves have a high value. It those prices plunge, the borrowing base for their revolving lines of credit plunges. S&P Capital IQ explained it this way in its report, “Waiting for the Spring… Will it Recoil”:

Typically, banks do their credit facility redeterminations in April and November with one random redetermination if needed. With oil prices plummeting, we expect banks to lower their price decks, which will then lead to lower reserves and thus, reduced borrowing-base availability.

April is coming up soon. These companies would then have to issue bonds to pay down their credit lines. But with bond fund managers losing their appetite for junk-rated oil & gas bonds, and with shares nearly worthless, these companies are blocked from the capital markets and can neither pay back the banks nor fund their cash-flow negative operations. For many companies, according to S&P Capital IQ, these redeterminations of their credit facilities could lead to a “liquidity death spiral.”

Alan Holtz, Managing Director in AlixPartners’ Turnaround and Restructuring group told LCD in an interview:

We are already starting to see companies that on the one hand are trying to work out their operational problems and are looking for financing or a way out through the capital markets, while on the other hand are preparing for the events of contingency planning or bankruptcy.

Look at BPZ Resources. It wasn’t able to raise more money and ended up filing for bankruptcy. “I think that is going to be a pattern for many other companies out there as well,” Holtz said.

When it trickled out on Tuesday that Hercules Offshore, which I last wrote about on March 3, had retained Lazard to explore options for its capital structure, its bonds plunged as low as 28 cents on the dollar. By Friday, its stock closed at $0.41 a share.

When Midstates Petroleum announced that it had hired an interim CEO and put a restructuring specialist on its board of directors, its bonds got knocked down, and its shares plummeted 33% during the week, closing at $0.77 a share on Friday.

When news emerged that Walter Energy hired legal counsel Paul Weiss to explore restructuring options, its first-lien notes – whose investors thought they’d see a reasonable recovery in case of bankruptcy – dropped to 64.5 cents on the dollar by Thursday. Its stock plunged 63% during the week to close at $0.33 a share on Friday.

Numerous other oil and gas companies are heading down that path as the oil bust is working its way from smaller more vulnerable companies to larger ones. In the process, stockholders get wiped out. Bondholders get to fight with other creditors over the scraps. But restructuring firms are licking their chops, after a Fed-induced dry spell that had lasted for years.

There is a sliver of hope, or false hope, on the way. The oil industry, it seems, has been lobbying the government. And the government has given in. It was announced Friday afternoon when consumers aren’t supposed to pay attention. Read… US Government Plans to Bail out Oil Industry, Consumers to Pay

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  6 comments for “Junk-Rated Oil & Gas Companies in a “Liquidity Death Spiral”

  1. mick
    Mar 15, 2015 at 9:38 pm

    Not sure why this govt story is being positioned as a bail out, it’s nothing of the sort. In fact, it was DOA and is already old news. If the govt wanted to bail out producers, they would commit to a long term, or massive one time investment.

    They have done nothing of the sort.

  2. Mike R.
    Mar 16, 2015 at 6:07 am

    The bailout of this mess will come, I feel certain. The moral hazard of bailout was crossed even before the bailouts of 09 and 10. The moral hazard of supporting our economy with unsustainable debt was conceived and launched under Clinton. Everything since then is simply a result.

    The bailout may not be as open and public as the last go around; not sure. But I can see ‘rationalization’/justification along the lines of national energy security, even though some will know this is bogus. At any rate, we’re still early in the debacle, more months to play out.

  3. Petunia
    Mar 16, 2015 at 10:24 am

    When the price of oil peaked everyone was quick to increase their prices, add transportation fees, and every bill seemed to go up because of the higher energy price. Now that the price of oil is down only the gas price has decreased. When do I see my electric bill go down or the extra airline fuel fees go away?

  4. Spencer
    Mar 16, 2015 at 10:34 am

    Below the January lows now,

    …”http://www.zerohedge.com/news/2015-03-16/oil-” tumbles-under-43-key-support-breached-fresh-6-year-lows “…

    and with talk of bailouts,

    …” http://www.zerohedge.com/news/2015-03-14/cancel-all-student-debt-petitions-begin

    Who will bail out the taxpayers? Besides, the pump prices are not reflected to the death spiral in oil. Manipulation? Duh!

    Cheers.

  5. Julian the Apostate
    Mar 17, 2015 at 4:53 pm

    Fossil fuels are on Obama’s enemies list. He is perfectly content to let the “free market” do his light work for him. The “bailout” is for the optics only. If they do put any serious effort into it I’ll be very much surprised.

  6. zapster
    Mar 18, 2015 at 9:47 am

    And of course, it would dawn on nobody that there are huge investment opportunities in shifting to alternative fuels and hiring the unemployed to implement them. Demand will continue to fall as those that don’t work in the oil industry or profit from it–and are increasingly clobbered by climate change–find ways to avoid using it, and as less and less real money is allowed to leak to the bottom where it’s most needed. Driving wages down reduces driving. This simple concept seems to completely escape those that are wedded to the idea that labor is their enemy. You want investment–invest in *raising the standard of living for everyone.*

    Meanwhile solar continues to grow as fast as the very limited financing available for it will allow.

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